Piedmont Office Realty Trust, Inc. (NYSE:PDM) Q1 2024 Earnings Call Transcript

Piedmont Office Realty Trust, Inc. (NYSE:PDM) Q1 2024 Earnings Call Transcript May 1, 2024

Piedmont Office Realty Trust, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day and welcome to the Piedmont Office Realty Trust Incorporated First Quarter 2024 Earnings Call. [Operator Instructions] It is now my pleasure to turn the floor over to your host, Chief Accounting Officer, Laura Moon. The floor is yours.

Laura Moon: Thank you, operator and good morning everyone. We appreciate you joining us today for Piedmont’s first quarter 2024 earnings conference call. Last night, we filed our Form 10-Q and an 8-K that includes our earnings release and our unaudited supplemental information for the first quarter of ‘24 that is available for your review on our website at piedmontreit.com under the Investor Relations section. During this call, you will hear from senior officers at Piedmont. Their prepared remarks followed by answers to your questions will contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements address matters, which are subject to risks and uncertainties and therefore actual results may differ from those we anticipate and discuss today.

The risks and uncertainties of these forward-looking statements are discussed in our press release as well as our SEC filings. We encourage everyone to review the more detailed discussion related to risks associated with forward-looking statements in our SEC filings. Examples of forward-looking statements include those related to Piedmont’s future revenues and operating income, dividends and financial guidance, future financing, leasing and investment activity and the impacts of this activity on the company’s financial and operational results. You should not place any undue reliance on any of these forward-looking statements and these statements are based upon the information and estimates we have reviewed as of the date the statements are made.

Also on today’s call representatives of the company may refer to certain non-GAAP financial measures such as FFO, core FFO, AFFO and same-store NOI. The definitions and reconciliations of these non-GAAP measures are contained in the earnings release and in the supplemental financial information, which were filed last night. At this time, our President and Chief Executive Officer, Brent Smith, will provide some opening comments regarding first quarter operating results. Brent?

Brent Smith: Thanks, Laura. Good morning, everyone and thank you for joining us today as we review our first quarter results. In addition to Laura, on the line with me this morning, are George Wells, our Chief Operating Officer; Chris Kollme, our EVP of Investments; and Bobby Bowers, our Chief Financial Officer. We also have the usual full complement of our management team available to answer your questions. We also have the usual full complement of our management team available to answer your questions. We had a strong start to the year at Piedmont, achieving significant levels of new tenant leasing as well as completing meaningful financing and capital markets transactions to improve the company’s balance sheet and liquidity position.

Looking ahead to the remainder of the year, we continue to be optimistic about the secular trends that are driving our leasing momentum, benefiting from the continued population migration to the Sunbelt in the suburbs, the flight to quality and capital within the office sector, and the continued differentiation between obsolete product and the well located amenitized environments that we provide and operate. No doubt, our sector has challenges remaining as commodity office space is rationalized and repurposed. That said, return to the office mandates continue to be the norm and groundbreakings for new developments are at all time lows. We are seeing space demand accelerate for our top of submarket assets in cities like Atlanta, Dallas, Orlando, New York and Minneapolis, giving us the expectation that Piedmont can continue to drive leasing momentum and rental rate growth at our buildings.

With regard to the capital markets, transaction activity remains at all-time lows, but pricing is starting to firm as deals occur. We don’t anticipate a meaningful number of opportunities will present themselves until later this year or more likely in 2025. As debt and equity for office assets remains extremely difficult to source inhibiting transactions. That said, the public unsecured debt markets are more constructive and liquidity and investor interest continues to improve. As a point of reference, our credit spreads have tightened roughly 250 basis points over the last year. Piedmont is well positioned as the credit cycle improves. We have a very manageable $275 million of maturing debt in 2025 and no debt maturities in 2026. With demonstrated access to the public debt markets, we will continue to seek out attractive sources of capital to strengthen the balance sheet and lower our cost of funds.

Turning to the highlights from the first quarter, as has been the case for the last several quarters, leasing volume remained strong. We completed approximately 500,000 square feet of total leasing with two-thirds of that related to new tenancy, pushing the lease percentage of our in-service portfolio up to 87.8% and continuing the occupancy gains that we have experienced over the last several quarters. I would note that during the quarter we dispose of our 257,000 square foot One Lincoln Park asset in Dallas to an end user. And as discussed in last quarter’s call, we gave our 9320 Excelsior building in Minneapolis and out of service designation as we commence redevelopment activities to upgrade the building to accommodate multiple tenants following the expiration of a full building lease at the end of last year.

George will delve into market specifics and details on the leasing pipeline in a moment. But our operational strategy is continuing to resonate with numerous customer segments, small and medium-sized businesses as well as larger corporate enterprises as they seek to upgrade their workplace environments. As a result of the leasing activity we have accomplished, Piedmont has continued to drive operational growth despite market headwinds. For the first quarter, our same-store NOI increased approximately 5% on a cash basis. And I would point out that this is a consistently strong metric for Piedmont, where we have generated positive same-store NOI cash growth 7 of the last 8 years, with the only exception being in 2020 due to COVID. In addition, rental rate roll-ups on a cash basis continued their positive trend, increasing roughly 8% for the quarter and adding to Piedmont’s track record of 8 straight years of positive cash rental rate roll-ups.

We firmly believe that these two operational metrics demonstrate the portfolio’s ability to deliver cash flow growth through real estate cycles. The leasing success over the last several quarters has generated a backlog of 1.3 million square feet of leases yet to commence or in a rent abatement. This equates to approximately $42 million in future annualized cash rents once the leases commence and abatements burn off. Over time, this lease backlog will more than offset the lost rental revenue from the previously disclosed expirations at Meridian Crossing and 9320 Excelsior Boulevard in Suburban Minneapolis. And as far as an update on those projects, we are executing a repositioning program at both buildings. And despite the disruption from construction and having marketed the buildings for only a few months, we are pleased to see strong receptivity from the market and have already executed 4 new leases for approximately 33,000 square feet at this point with more that’s in advanced documentation potentially following.

In fact, the leasing pipeline across the portfolio remains robust and thus far in the second quarter of 2024, we have already executed 22 leases for approximately 180,000 square feet. Lastly, before I turn it over to George, I wanted to note that we were recently once again named an ENERGY STAR Partner of the Year for 2024. However, this time, we received the highest designation, adding the sustained excellence distinction, which is awarded to organizations, who have earned Partner of the Year for several consecutive years and have gone beyond the criteria, needed to qualify for recognition. We are the only office REIT headquartered in the southeast to receive this premier designation. And we remain steadfast in our commitment to our employees, customers, stockholders and local communities to be a market leader in commercial building operations.

And we believe ENERGY STAR’s Sustained Excellence award recognizes our longstanding efforts to reduce energy consumption across our portfolio. I would encourage all our stakeholders to view our sustainability program and the quantifiable results achieved that are outlined in our annual environmental, social and governance report located on our website. With that, I’ll hand the call over to George, who will go into more details on first quarter operational results. George?

George Wells: Thanks, Brent. Good morning, everyone. Our regional teams were once again very productive this quarter, delivering strong operational results. All of our core markets experienced solid demand, dominated by small to medium-sized businesses that had a clear vision for the long-term workplace strategy, desiring to operate in modern, highly amenitized workplace environment, which is a crucial element for these customers seeking more in-person attendance and interaction. According to JLL’s March 11th Snapshot Report, highly amenitized buildings, which are defined as assets with 10 or more amenities and at least 1 differentiated offerings like a rooftop terrace or a full-service fitness center have resisted the broader downsizing trend impacting much of the U.S. office market.

Piedmont is certainly experiencing this positive trend, and I’m optimistic we can continue to deliver strong leasing results in 2024. As Brent mentioned in his remarks, during the quarter, we completed 54 lease transactions for 500,000 square feet of total overall volume in line with our quarterly averages. And majority of that volume was related to new tenant lease activity accounting for 30 transactions for 328,000 square feet, which is substantially above our pre-COVID quarterly average of 165,000 square feet and representing roughly 13% of our overall direct in-service vacancy. The average lease size of new tenant leases completed as approximately 11,000 square feet consistent with the previous quarters with the weighted average lease term achieved in over 9 years.

Continuing with operational metrics, lease economics were quite favorable as well with 8% and 18% roll-up or increased rents for the quarter on a cash and accrual basis respectively. The leasing success contributed to the increase of our lease percentage for our in-service portfolio to end the quarter at 87.8%. As we have experienced for several quarters, most of our new tenant lease activity or 80% occurred in our Sunbelt portfolio where 63% of our vacancies reside. Leasing capital spend for the quarter was approximately $6 per square foot per lease year in line with our average for the past several quarters, although competition, inflation and supply chain logistics continue to put pressure on this capital metric. During the quarter, we did have 7 tenant lease expansions that were largely offset by 3 contractions and sublease availability has continued to hover on the last quarter’s average of approximately 5%.

Next, I’d like to highlight for you a few key accomplishments and announcements occurring in some of our specific operating markets this quarter. Atlanta, our largest market, captured the most activity this quarter with 15 deals accounting for 142,000 square feet, of which 75% were new tenant leases. Most noteworthy, Assurance America, a national insurance operator, relocated its headquarters to a full floor in Galleria on the Park for 10 years of term. Securing another corporate headquarters in Galleria, our 9th since 2022, continues to support the flight to quality theme or more aptly as Piedmont sees it, a flight to place-making experience, which builds upon well-located, high-quality real estate, which include hospitality design common areas here with high-quality service.

We believe our modern aftermarket amenity set at 999 Peachtree will be a very compelling option for existing tenant retention and for attracting new tenants. And along with our 1180 Peachtree asset gives us the two best assets in Midtown. Elsewhere in the submarket, another major employer, NCR Voyix, whose 14-storey towers near our two Midtown trophy assets has announced that all pay-produced personnel will report to the office 5 days a week beginning May 6, reinforcing the trend of more in-office work. Our Dallas portfolio captured the second most leasing volume with 7 deals for 128,000 square feet, almost 90% of the volume was for new space, and completed in each of our four submarkets of Uptown, Las Colinas, Lower Tollway and Preston Center.

We anticipate this broad-based demand to continue, which bodes well for addressing our Dallas exposure over the next 4 quarters, the largest of our select markets. Notable and subsequent to the first quarter, we amended [indiscernible] to accommodate an expansion of 8,000 square feet, an extension of a full floor from 2025 to 2029 and another extension of 54,000 square feet for 14 months. Along with other ongoing extension negotiations, we feel good about mitigating a majority of the lease maturities in Dallas over the next 12 months or put another way, we’ll achieve retention rates in line with our historical average. Switching to New York. Our 60 Broad Street tower located in Lower Manhattan, attracted 3 new tenant deals for 28,000 square feet.

Prospects here have been attracted to this highly amenitized city block and a recently completed Morris Adjmi design lobby renovation with CoStar now rating our 60 Broad location with a top Walker’s Paradise score. We’re seeing very good activity here with some customers coming to several nearby office to resi conversions such as 55 Broad Street, 80 Pine and others. Extension discussions with the City of New York continue at a predictably slow governmental pace, but are still ongoing and are positive. Coming back to our overall portfolio, we remain positive about our future near-term leasing trends. As Brent previewed, our leasing pipeline activity is quite good with over 700,000 square feet in late-stage activity, considerably higher than our norm of around 300,000 to 400,000 square feet.

Outstanding proposals sit at well over 2 million square feet comparable to our trailing 12 months and tour activity was the strongest we’ve seen since early 2020. That said, as we noted in our last call when discussing the outlook for 2024, we project that the lease percentage should dip below our current level during the second quarter, mostly due to U.S. bank suburban expiration, but then recover back to today’s in-service percentage of around 87% to 88% by year end. I’ll now turn the call over to Chris Kollme for any comments on investment activity. Chris?

Chris Kollme: Thank you, George. As I’ve mentioned over the last several quarters, we continued disposition discussions on a select number of non-core assets with mostly local operators or owner-occupiers who are targeting our smaller assets, generally those less than 250,000 square feet. As Brent mentioned, this quarter, we closed one transaction of this nature, selling our One Lincoln Park asset in Dallas for $54 million or $210 per square foot in an all-cash transaction to a financial institution who plans to use the building as its new headquarters location. One Lincoln Park is a 10-storey, approximately 257,000 square foot building, which was 59% leased as of December 31, 2023. While this asset is located in one of our core Sunbelt markets and not one that we would have necessarily targeted for disposition, this was an opportunity to sell at what we consider to be fair value given the estimated capital required to lease-up the balance of the building.

We immediately redeployed the proceeds from the sale to pay off our remaining 2024 notes on an earnings-neutral basis. Furthermore, Piedmont has been retained as property manager post-sale. As far as other activity, we do have a couple of other small disposition opportunities that we’re working on, but nothing to specifically comment on at this time. We still do anticipate disposing of an incremental $40 million to $60 million more over the balance of 2024. As always, we will keep you informed of any material activity on this front and we’ll continue to earmark any resulting sale proceeds towards the reduction of debt. And while acquisitions are not a priority at this time, we do remain highly engaged across our operating markets with a very strong bias towards our Sunbelt cities.

With our scale, operational platform and deep local relationships, we believe opportunities may surface by year end or in early 2025, but we will continue to be disciplined and patient, which we think is appropriate in this environment. With that mindset, we will continue to position the balance sheet to take advantage of the conditions if and when compelling opportunities arise. With that, I’ll turn the call over to Bobby to review our financial results. Bobby?

Bobby Bowers: Thank you, Chris. While I will be discussing some of this quarter’s financial highlights today, please review the entire earnings release, the 10-Q and the accompanying supplemental financial information, which were filed yesterday for more complete details. Core FFO per diluted share for the first quarter of 2024 was $0.39 versus $0.46 per diluted share for the first quarter of 2023. Although property NOI increased on both a cash and accrual basis during the first quarter of 2024 as compared to the first quarter of last year, the first quarter of 2024 reflects a little over $0.06 per share of increased net interest expense, which led to an overall decreased core FFO per share results for the quarter. AFFO generated during the first quarter of 2024 was approximately $25 million, providing ample coverage of the current dividend and funding for our foreseeable capital needs.

CapEx for the quarter was elevated due to major redevelopment activities at 999 Peachtree and Galleria on the Park in Atlanta and the exchange of South Orange Avenue in Orlando, which are all scheduled to be completed during the third quarter of this year. Turning to the balance sheet. As we announced in conjunction with last quarter’s call, during January of the first quarter, we completed a $200 million 3-year unsecured term loan with our key banking relationships and used the bulk of these proceeds to repay $190 million of a $215 million term loan that was scheduled to mature in January, extending out the remaining $25 million to a 2025 maturity. In conjunction with that transaction, we also used the remaining proceeds in our line of credit to repay the outstanding $100 million balance of another bank term loan.

Further, in March, as Chris indicated, we used net proceeds from the One Lincoln Park disposition to repay the remaining $50 million balance on our 2024 senior notes that also matured in March. As a result of this quarter’s refinancing activity, we have only $275 million of bank term debt maturing until 2027. And we currently anticipate repaying this debt using a combination of net proceeds from the disposition of select properties, availability on our $600 million line of credit and/or new borrowings from our bank partners or the public debt market. The nature and timing of any of these additional sources of capital is obviously highly dependent on market conditions. However, we’ll strive to address this debt maturity over the next few months, while continuing to preserve our large unencumbered asset pool as we believe this is a clear advantage in the current leasing environment as high-quality, place-making asset owners that are well-capitalized, continue to garner outsized leasing demand.

Finally, at this time, I’d like to also reaffirm our 2024 annual core FFO guidance in the range of $1.46 to $1.56 per diluted share with no significant changes currently anticipated in prior guidance related to interest expense, G&A costs or annual same-store NOI growth. In keeping with our normal practice, due to the uncertain nature of capital markets environment, this guidance does not include any acquisition, disposition or refinancing activity, but we will adjust and communicate to you the impacts on guidance if any of these transactions occur. With that, I’ll turn the call back over to Brent for closing comments.

Brent Smith: Thank you, George, Chris and Bobby. Everyone at Piedmont remains laser-focused on our core business, designing, managing and leasing great office space. Despite the macro challenges, the office sector paces. The investments that we’ve made in our portfolio combined with the best-in-class service model is resonating with existing and prospective tenants alike. And aside from the one large known move-out during the second quarter, we have a very manageable lease expiration scheduled for the remainder of the year, equating to approximately 5% of annualized lease revenues that have not already been backfilled. I would also note that the majority of our vacancies reside in our Sunbelt markets where we see a healthy and growing pipeline of prospects.

Piedmont’s balance sheet is well positioned with limited outstanding maturities over the next 3 years. And we continue to be selective with capital deployment and anticipate being a net seller of assets to continue to deleverage the balance sheet and enhance our already ample liquidity resources. However, as indicated when we originally introduced our 2024 guidance back in February, we expect the impact of increased interest expense and known vacates to result in earnings and vacancy trough in the third quarter with an anticipated return to quarterly FFO growth thereafter. With that, I will now ask the operator to provide our listeners with instructions on how they can submit their questions. We will attempt to answer all of your questions now or we will make appropriate later disclosure if necessary.

Operator?

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Q&A Session

Operator: [Operator Instructions] Your first question is coming from Anthony Paolone with JPMorgan. Please pose your questions. Your line is live.

Anthony Paolone: Great. Thank you. My first question is with regards to dispositions, I think you said $40 million to $60 million. And I was wondering if you can give us a sense as to whether that’s operating assets or it looks like you’ve got some land parcels under contract as well? So I’m just trying to understand what might be in that mix.

Brent Smith: Good morning, Tony, I appreciate you joining us. As you point out, we were very pleased to get the Dallas disposition accomplished, but we did allude to another $40 million or $60 million or so later this year. That’s comprised of potential both land and operating parcels. I think as you know our model for some time, we always say everything is for sale. We’ve been historically prolific recyclers and we’ve used that as a means to grow earnings. But in this market, it is very challenging from a disposition standpoint. It seems like everything prices opportunistically even if it’s a core profile asset in nature. But we continue to find, as we’ve noted in our prepared remarks, user groups that are well capitalized as well as smaller local private equity shops and the high net worth individuals who recognize the market opportunity, see the value in certain assets and we continue to engage with them on some of those potential dispositions.

As I’ve noted in the past, Houston is still a non-core market and we are engaged with several potential buyers or acquirers of those assets. We’re hopeful that one of the two will get completed by the end of the year. And then other than that, into other just kind of smaller assets and/or potential landfill parcels. So it’s a combination of both, although I think it’s probably more likely this year to be assets not land. Those do take quite some time to accomplish. And as we think about those land parcels, we’re looking probably more towards creating an amenity set at our neighboring office buildings. So they’re likely engaged on other uses to go on that land, whether it be typically residential, hotel or retail.

Anthony Paolone: Okay. Got it. So it looks like the couple of parcels you’ve got under contract are subject to zoning. Are those being – like is it likely to go residential? Is that what the hold-up is or what’s going on there?

Brent Smith: Very keen exactly. It’s likely to go residential and includes some retail that we would also utilize and we see more of the, call it, amenity to the office.

Chris Kollme: And Tony, it’s Chris. I think those are highly unlikely to close in 2024.

Anthony Paolone: Okay. So probably not in that $40 million to $60 million then for this year?

Chris Kollme: Yes.

Anthony Paolone: Okay. Got it. And then any update on City of New York and just the lease there or any risk of that just getting downsized or the sort of picture changing?

Brent Smith: Well, I think as you know, Tony, nothing is done until it’s done. But that said, we feel very good and we’ve always continued to reiterate that the city is very much engaged on a renewal. I think that probably gets wrapped up some time latter part of this year is what we’re thinking from a timing perspective. It does have to go through a lot of internal processes. And as we’ve talked about on prior calls, they waffle back and forth on which groups would be in the space, their ability to focus on at renewal at that point in time given the difficulties of the agencies and what’s been going on in the city from a migrant housing crisis, a homeless crisis and a budget crisis. But they are very much engaged and we still feel very comfortable to say it’s a renewal of substantially all the space.

Anthony Paolone: Okay. And just last one, maybe for Bob, if I could sneak this one in. Just do you know off-hand how much in committed CapEx is outstanding that just hasn’t yet been spent, I guess, for some of these large leases that you’ve gotten done?

Brent Smith: Yes. Tony, in our supplemental, where in our disclosure, we do note there’s really just one large project outstanding for the company and that’s really related to the large U.S. bank lease that we just executed last quarter. As a reminder, that was a 10-year transaction with no free rent. And so what that did given it’s a – sorry, 450,000 square foot lease, it does have a sizable capital outlay. Other than that – and I would add, it will take us 2 to 3 years to spend that sizable capital outlay, which as we noted on our previous call, was approaching a triple-digit number from a capital per square foot total amount. So that’s a sizable check. Though that will come in over several years that we’ll be reconstructing the bank space, but again, attached to a great long-term lease and it’s their headquarters building in a lead gold asset.

So, we are going to keep that building top of market which also gives us the expectation will be continuing to get more than our fair share of leasing in Downtown Minneapolis with the best asset in the sub-market. In regards to – sorry, Bobby, is there anything else that you would add in terms of a large tenant, or large CapEx we have not disclosed, but you would highlight?

Bobby Bowers: Yes. I wouldn’t say on the tenant side that there is some. Obviously, this quarter, we had higher than normal redevelopment costs, that’s associated with us finishing up major redevelopment projects being something as $10 million or so in size, that’s at 60 Broad, Manhattan, Peachtree in the Galleria, here in Atlanta, and the exchange of Orlando. I have mentioned that was part of the MD&A. That’s included in our 10 Q. There is a detail $70 million was spent there. In total, what remains for all of those projects is less than that, about $50 million in total over the next couple of quarters.